2012-2013 Tax Planning Guide Year-round strategies to make the tax laws work for youServing the Pacific Northwest for over 75 years providing assurance, tax and consulting services5885 Meadows Road, Suite 200Lake Oswego, OR 97035(503) 697-4118E-mail: firstname.lastname@example.org
DEDUCTIONS & AMT Click here 2 F A M I LY & E D U C A T I O N Click here 4 INVESTING 6 Click here BUSINESS 8 Click here RETIREMENT 12 Click here ESTATE PLANNING Click here 14 TAX RATES Click here 16In these uncertain times, planningis more important than everMinimizing taxes is never easy. But in times of legislative and economic uncertainty, it can be a real challenge.As of this writing, the lower tax rates currently in effect are scheduled to expire at the end of 2012. Whetherthey’ll be extended, raised or changed in some other way is anyone’s guess.This means you’ll need to base your tax plan on the way things are now but be ready to revise it in a flash ifCongress makes significant tax law changes before year end. The more you know about the areas subject tochange, and the more familiar you are with various tax planning strategies, the easier it will be to determineyour best course of action.This guide is intended to help you do exactly that. But we don’t have room here to cover all strategies thatmay apply to your situation. So please check with your tax advisor to find out the latest information and thebest ways to minimize your tax liability for 2012 and beyond.
DEDUCTIONS & AMTRising rates and expiring breaks complicate tax planning Deductions are more powerful when tax rates are higher because they save tax at that higher rate — a $1,000 deduction saves you $280 when your tax rate is 28% but $310 when your tax rate is 31%. With tax rates, as of this writing, scheduled to rise in 2013, you may want to defer, where possible, incurring deductible expenses to next year, when they might save more tax. But the tax advantage could be reduced or eliminated by the expiration of certain tax breaks. An income-based phaseout limiting the benefit of many deductions, for example, is scheduled to return for 2013. Yet it’s possible that lower rates and various breaks could be extended. So planning for deductions is especially complicated this year.The AMT Charitable donations sold the property. Warning: DonationsWhen planning for deductions, the Donations to qualified charities are gen- of such property are subject to tighterfirst step is to consider the alternative erally fully deductible for both regular deduction limits. Excess contributions canminimum tax (AMT) — a separate tax tax and AMT purposes, and they may be be carried forward for up to five years.system that limits some deductions and the easiest deductible expense to time to CRTs. For a given term, a charitabledoesn’t permit others, such as: your tax advantage. After all, you control remainder trust pays an amount to exactly when and how much you give. you annually (some of which may be n State and local income tax For large donations, discuss with your taxable). At the term’s end, the CRT’s deductions, tax advisor which assets to give and the remaining assets pass to one or more n Property tax deductions, and best ways to give them. For example: charities. When you fund the CRT, you n Miscellaneous itemized deductions Appreciated assets. Publicly traded stock receive an income tax deduction. If you subject to the 2% of adjusted gross contribute appreciated assets, you also and other securities you’ve held more income (AGI) floor, including invest- may be able to minimize and defer capi- than one year are long-term capital gains ment expenses and unreimbursed tal gains tax. You can name someone property, which can make one of the best employee business expenses. other than yourself as income benefi- charitable gifts. Why? Because you canYou must pay the AMT if your AMT deduct the current fair market value and ciary or fund the CRT at your death, butliability exceeds your regular tax liability. avoid the capital gains tax you’d pay if you the tax consequences will be different.(See Chart 7 on page 16 for AMT ratesand exemptions.) You may be able totime income and deductions to avoid CHART 1 Scheduled ordinary income tax rate increasesthe AMT, reduce its impact or even takeadvantage of its lower maximum rate. 2012 rate 2013 rate1But, such planning will be a challenge 10% 15%until Congress passes long-term relief. 15% 15%Unlike the regular tax system, the AMTsystem isn’t regularly adjusted for infla- 25% 28%tion. Instead, Congress must legislate any 28% 31%adjustments. Typically, it has done so viaan increase in the AMT exemption. Such 33% 36%a “patch” was in effect for 2011, but, as 35% 39.6%of this writing, Congress hasn’t passeda patch for 2012. (Check with your tax ssuming legislation isn’t signed into law extending lower rates or making other rate 1 A changes. Contact your tax advisor for the latest information.advisor for the latest information.)
DEDUCTIONS AMT 3Home-related breaks Medical expense deductionThese valuable tax breaks go beyond WHAT’S NEW! floor scheduled to rise in 2013just deductions: Who’s affected: Taxpayers who incur medical expenses.Property tax deduction. Before payingyour bill early to accelerate the itemized Key changes: Currently, if your eligible medical expenses exceed 7.5% ofdeduction into 2012, review your AMT your adjusted gross income (AGI), you can deduct the excess amount. But insituation. If you’re subject to the AMT, 2013, the 2010 health care act increases this “floor” to 10% for taxpayersyou’ll lose the benefit of the deduction under age 65.for the prepayment. Eligible expenses can include health insurance premiums, medical and dentalMortgage interest deduction. You services and prescription drugs. Expenses that are reimbursed (or reimbursable)generally can deduct interest on up to by insurance or paid through a tax-advantaged health care account aren’t eligible.a combined total of $1 million of mort- Planning tips: Consider “bunching” nonurgent medical procedures and othergage debt incurred to purchase, build controllable expenses into one year to exceed the AGI floor. Bunching expensesor improve your principal residence and into 2012 may be especially beneficial because of the scheduled floor increase.a second residence. Points paid related But keep in mind that, for alternative minimum tax purposes, the 10% floorto your principal residence also may be already applies. Also, if tax rates go up in 2013 as scheduled, your deductionsdeductible. might be more powerful then. Finally, be aware that the floor increase could beHome equity debt interest deduction. repealed by Congress.Interest on home equity debt used toimprove your principal residence — and joint filers) of gain if you meet certain the latest information.) When available,interest on home equity debt used for any tests. Warning: Gain that’s allocable to the deduction can be valuable to tax-purpose (debt limit of $100,000) — may a period of “nonqualified” use generally payers who reside in states with no orbe deductible. So consider using a home isn’t excludible. low income tax or who purchase majorequity loan or line of credit to pay off items, such as a car or boat. Home sale loss deduction. Losses oncredit cards or auto loans, for which inter- the sale of a principal residence aren’test isn’t deductible. Warning: Beware of Saving for health care deductible. But if part of your home isthe AMT — if the home equity debt isn’t Here are two tax-advantaged vehicles rented or used exclusively for your busi-used for home improvements, the interest you should consider if available to you: ness, the loss attributable to that portionisn’t deductible for AMT purposes. will be deductible, subject to various 1. HSA. If you’re covered by qualifiedHome office deduction. If your use limitations. high-deductible health insurance, aof a home office is for your employer’s Health Savings Account allows contribu- Debt forgiveness exclusion. Home-benefit and it’s the only use of the space, tions of pretax income (or deductible owners who receive debt forgivenessyou generally can deduct a portion of after-tax contributions) up to $3,100 in a foreclosure, short sale or mortgageyour mortgage interest, real estate taxes, for self-only coverage and $6,250 for workout for a principal residence gener-insurance, utilities and certain other family coverage (for 2012). Account ally don’t have to pay federal incomeexpenses, as well as the depreciation holders age 55 and older can contribute taxes on that forgiveness. Warning: Asallocable to the office space. You can an additional $1,000. of this writing, this break is scheduled toalso deduct direct expenses, such as expire after 2012. HSAs bear interest or are invested andbusiness-only phone lines. can grow tax-deferred similar to an Rental income exclusion. If you rentYou must claim these expenses as a IRA. Withdrawals for qualified medical out all or a portion of your principalmiscellaneous itemized deduction, expenses are tax-free, and you can carry residence or second home for less thanwhich means you’ll enjoy a tax ben- over a balance from year to year. 15 days, you don’t have to report theefit only if your home office expenses income. But expenses associated with 2. FSA. You can redirect pretax income toplus your other miscellaneous itemized the rental won’t be deductible. an employer-sponsored Flexible Spendingexpenses exceed 2% of your AGI. If, Account up to an employer-determinedhowever, you’re self-employed, you Sales tax deduction limit (not to exceed $2,500 for plancan use the deduction to offset your The break allowing you to take an item- years beginning in 2013). The plan paysself-employment income and the 2% ized deduction for state and local sales or reimburses you for qualified medicalof AGI “floor” won’t apply. taxes in lieu of state and local income expenses. What you don’t use by the endHome sale gain exclusion. When you taxes was available for 2011 but, as of of the plan year, you generally lose. Ifsell your principal residence, you can this writing, hasn’t been extended for you have an HSA, your FSA is limited toexclude up to $250,000 ($500,000 for 2012. (Check with your tax advisor for funding certain “permitted” expenses. w
F A M I LY E D U C A T I O NGreen your family tree with these tax-saving opportunities Many ways to save tax dollars are available to parents, students and even grandparents. So take advantage of the deductions, credits and tax-advantaged savings opportunities available to you and your family. Also be aware that certain breaks will become less beneficial in 2013 if Congress doesn’t take action to extend the enhancements currently in effect.Child and adoption credits IRAs for teens or she will gain no benefit from the abil-Tax credits reduce your tax bill dollar- IRAs can be perfect for teenagers because ity to deduct a traditional IRA contribu-for-dollar, so make sure you’re taking they likely will have many years to let their tion. (For more on IRAs, see page 12.)every credit you’re entitled to. For each accounts grow tax-deferred or tax-free. If your children or grandchildren don’tchild under age 17 at the end of the The 2012 contribution limit is the lesser want to invest their hard-earned money,year, you may be able to claim a $1,000 of $5,000 or 100% of earned income. consider giving them the amount they’rechild credit. If you adopt in 2012, you Traditional IRA contributions generally eligible to contribute — but keep themay qualify for an adoption credit or an are deductible, but distributions will be gift tax in mind. (See page 14.) If theyemployer adoption assistance program taxed. On the other hand, Roth IRA don’t have earned income and you ownincome exclusion; both are $12,650 per contributions aren’t deductible, but a business, consider hiring them. As theeligible child. qualified distributions will be tax-free. business owner, you can deduct theirWarning: These credits phase out for Choosing a Roth IRA is a no-brainer if a pay, and other tax benefits may apply.higher-income taxpayers. (See Chart 2.) teen doesn’t earn income that exceeds Warning: Your children must be paid the standard deduction ($5,950 for in line with what you’d pay nonfamilyChild care expenses 2012 for single taxpayers), because he employees for the same work.A couple of tax breaks can help youoffset these costs:Tax credit. For children under age 13or other qualifying dependents, youmay be eligible for a credit for a por-tion of your dependent care expenses.Eligible expenses are limited to $3,000for one dependent and $6,000 for twoor more. Income-based limits reduce thecredit but don’t phase it out altogether.(See Chart 2.)FSA. You can contribute up to $5,000pretax to an employer-sponsored childand dependent care Flexible SpendingAccount. The plan pays or reimburses youfor these expenses. You can’t use thosesame expenses to claim a tax credit.
F A M I LY E D U C A T I O N 5 precollege expenses will be taxable 2012 family and education CHART 2 starting in 2013. Additionally, the annual tax breaks: Are you eligible? ESA contribution limit per beneficiary is Modified adjusted gross only $2,000 through 2012, and it will Tax break income phaseout range go down to $500 for 2013 if Congress Single filer Joint filer doesn’t act. Contributions are further limited based on income. (See Chart 2.) Child credit 1 $ 75,000 – $ 95,000 $ 110,000 – $ 130,000 Adoption credit $ 189,710 – $ 229,710 $ 189,710 – $ 229,710 Generally, contributions can be made Child or dependent care credit2 $ 15,000 – $ 43,000 $ 15,000 – $ 43,000 only for the benefit of a child under age 18. Amounts left in an ESA when ESA contribution $ 95,000 – $ 110,000 $ 190,000 – $ 220,000 the beneficiary turns age 30 generally American Opportunity credit $ 80,000 – $ 90,000 $ 160,000 – $ 180,000 must be distributed within 30 days, and Lifetime Learning credit $ 52,000 – $ 62,000 $ 104,000 – $ 124,000 any earnings may be subject to tax and Student loan interest deduction $ 60,000 – $ 75,000 $ 125,000 –$ 155,000 a 10% penalty. 1 ssumes one child. The phaseout end is higher for families with more than one eligible child. A 2 he phaseout is based on AGI rather than MAGI. The credit doesn’t phase out altogether, T Education credits but the minimum credit percentage of 20% applies to AGIs above $43,000. and deductions If you have children in college now, areThe “kiddie tax” n The plans typically offer high con- currently in school yourself or are payingThe income shifting that once — when tribution limits, and there are no off student loans, you may be eligiblethe “kiddie tax” applied only to those income limits for contributing. for a credit or deduction:under age 14 — provided families with n There’s generally no beneficiary age American Opportunity credit. This taxsignificant tax savings now offers much limit for contributions or distributions. break covers 100% of the first $2,000more limited benefits. Today, the kiddie n You remain in control of the of tuition and related expenses andtax applies to children under age 19 account — even after the child is 25% of the next $2,000 of expenses.as well as to full-time students under of legal age. The maximum credit, per student, isage 24 (unless the students provide n You can make rollovers to another $2,500 per year for the first four years ofmore than half of their own support qualifying family member. postsecondary education. Warning: Thefrom earned income). n The plans provide estate plan- credit is scheduled to revert to the lessFor children subject to the kiddie tax, any ning benefits: A special break for beneficial Hope credit after 2012 butunearned income beyond $1,900 (for 529 plans allows you to front-load may be extended.2012) is taxed at their parents’ marginal five years’ worth of annual gift tax Lifetime Learning credit. If you’re pay-rate rather than their own, likely lower, exclusions and make a $65,000 ing postsecondary education expensesrate. Keep this in mind before transfer- contribution (or $130,000 if you beyond the first four years, you may bering income-generating assets to them. split the gift with your spouse). eligible for the Lifetime Learning credit The biggest downsides may be that your (up to $2,000 per tax return).Saving for education investment options — and when you Tuition and fees deduction. If youIf you’re saving for education, there can change them — are limited. don’t qualify for one of the creditsare two tax-advantaged vehicles youshould consider: 2. ESAs. Coverdell Education Savings because your income is too high, you Account contributions aren’t deductible might be eligible to deduct up to $4,0001. Section 529 plans. You can choose for federal purposes, but plan assets can of qualified higher education tuitiona prepaid tuition program to secure grow tax-deferred and distributions used and fees — if this break is extended forcurrent tuition rates or a tax-advantaged to pay qualified education expenses are 2012. (Check with your tax advisor forsavings plan to fund college expenses: income-tax-free. the latest information.) n Contributions aren’t deductible for Perhaps the biggest ESA advantage Student loan interest deduction. If federal purposes, but plan assets is that you have direct control over you’re paying off student loans, you can grow tax-deferred. how and where your contributions are may be able to deduct up to $2,500 n Distributions used to pay qualified of interest (per tax return). invested. Another advantage is that expenses (such as tuition, man- tax-free distributions aren’t limited to Warning: Income-based phaseouts datory fees, books, equipment, college expenses; they also can fund apply to these breaks (see Chart 2), supplies and, generally, room and elementary and secondary school costs. and expenses paid with 529 plan or board) are income-tax-free for federal purposes and may be tax- However, if Congress doesn’t extend ESA distributions can’t be used to free for state purposes. this treatment, distributions used for claim them. w
INVESTINGTime to take another look at theimpact of taxes on your portfolio When it comes to investing, the focus is often on returns — without regard to their potential tax impact. Because tax rates have been relatively low for the past several years, it’s not surprising that there’s been more focus on stock market volatility and low interest rates than on tax consequences. But, as of this writing, tax rates are scheduled to increase next year, so it’s time to take another look at the impact of taxes on your portfolio.Capital gains tax and timing Warning: You have only through 2012 Avoid wash sales. If you want toAlthough time, not timing, is generally to take advantage of the 15% rate, achieve a tax loss with minimal changethe key to long-term investment success, unless Congress extends it. (See “What’s in your portfolio’s asset allocation, keeptiming can have a dramatic impact on new!” below.) in mind the wash sale rule. It preventsthe tax consequences of investment you from taking a loss on a security if Here are some other tax-saving strate-activities. The 15% long-term capital you buy a substantially identical security gies related to timing:gains rate is 20 percentage points lower (or option to buy such a security) withinthan the highest ordinary-income rate of Use unrealized losses to absorb 30 days before or after you sell the35%. It generally applies to investments gains. To determine capital gains tax security that created the loss. You canheld for more than 12 months. (Higher liability, realized capital gains are netted recognize the loss only when you selllong-term gains rates apply to certain against any realized capital losses. If the replacement security.types of assets — see Chart 3.) you’ve cashed in some big gains during Fortunately, there are ways to avoid the year and want to reduce your 2012Holding on to an investment until triggering the wash sale rule and still tax liability, before year end look foryou’ve owned it more than a year may achieve your goals. For example, you can unrealized losses in your portfolio andhelp substantially cut tax on any gain. immediately buy securities of a different consider selling them to offset your gains. company in the same industry or shares in a mutual fund that holds securities much Low capital gains and qualified-dividend WHAT’S NEW! like the ones you sold. Or, you may wait rates set to expire Dec. 31 31 days to repurchase the same security. Who’s affected: Investors holding appreciated or dividend-producing assets. Alternatively, before selling the security, you can purchase additional shares of that Key changes: As of this writing, the 15% long-term capital gains rate is scheduled security equal to the number you want to to return to 20% in 2013. The 15% rate also applies to qualified dividends, and sell at a loss, and then wait 31 days to sell in 2013 these dividends are scheduled to return to being taxed at your marginal the original portion. ordinary-income rate — which likely is also scheduled to increase. (See Chart 1 on page 2.) It’s possible, however, that Congress will extend the lower rates or make Swap your bonds. With a bond swap, other rate changes. (Check with your tax advisor for the latest information.) you sell a bond, take a loss and then immediately buy another bond of similar Planning tips: If as year end approaches it’s looking like tax rates will increase next quality and duration from a different year, consider whether, before year end, you should sell highly appreciated assets issuer. Generally, the wash sale rule you’ve held long term. It may make sense to recognize gains now rather than risk doesn’t apply because the bonds aren’t paying tax at a higher rate next year. If you hold dividend-producing investments, considered substantially identical. Thus, consider whether you should make any adjustments to your portfolio in light of the you achieve a tax loss with virtually no higher tax rate that may apply to dividends in 2013. change in economic position.
INVESTING 7 ordinary-income rates. So, in terms of CHART 3 What’s the maximum capital gains tax rate? income investments, stocks that pay qualified dividends may be more attrac- Maximum tax rate for assets held 2012 20131 tive tax-wise than, for example, CDs or money market accounts. But nontax 12 months or less (short term) 35% 39.6% issues must be considered as well, such More than 12 months (long term) 15% 20% as investment risk and diversification. Some key exceptions Bonds. These also produce interest income, but the tax treatment varies: Long-term gain on collectibles, such as artwork 28% 28% and antiques n Interest on U.S. government bonds is taxable on federal returns but gener- Long-term gain attributable to certain recapture 25% 25% ally exempt on state and local returns. of prior depreciation on real property n Interest on state and local govern- Long-term gain that would be taxed at 15% or ment bonds is excludible on federal 0% 10% less based on the taxpayer’s ordinary-income rate returns. If the bonds were issued in 1 ssuming legislation isn’t signed into law extending lower rates or making other rate changes. A your home state, interest also may Contact your tax advisor for the latest information. be excludible on your state return. n Tax-exempt interest from certainMind your mutual funds. Mutual business that might generate substan- private-activity municipal bonds canfunds with high turnover rates can tial future capital gains. They’ll be even trigger or increase the alternativecreate income that’s taxed at ordinary- more powerful if rates go up in 2013. minimum tax (AMT, see page 2) inincome rates. Choosing funds that But if you don’t expect substantial future some situations.provide primarily long-term gains can gains, it could take a long time to fully n Corporate bond interest is fully tax-save you more tax dollars because of absorb a large loss carryover. So, from able for federal and state purposes.the lower long-term rates. a tax perspective, you may not want to n Bonds (except U.S. savings bonds)See if a loved one qualifies for the sell an investment at a loss if you won’t with original issue discount (OID)0% rate. The long-term capital gains have enough gains to absorb most of it. build up “interest” as they riserate is 0% for gain that would be taxed (Remember, however, that capital gains toward maturity. You’re generallyat 10% or 15% based on the taxpayer’s distributions from mutual funds can also considered to earn a portion ofordinary-income rate. If you have adult absorb capital losses.) Plus, if you hold that interest annually — evenchildren in one of these tax brackets, on to the investment, it may recover the though the bonds don’t pay thisconsider transferring appreciated assets lost value. interest annually — and you mustto them so they can enjoy the 0% rate. Nevertheless, if you’re ready to divest pay tax on it.Warning: The 0% rate is scheduled to yourself of a poorly performing invest- Stock options. Before exercising (orexpire after 2012, so you may want to ment because you think it will continue to postponing exercise of) options or sellingact soon. Also, if the child will be under lose value — or because your investment stock purchased via an exercise, consultage 24 on Dec. 31, first make sure he objective or risk tolerance has changed — your tax advisor about the complicatedor she won’t be subject to the “kiddie don’t hesitate solely for tax reasons. rules that may trigger regular tax ortax.” (See page 5.) Finally, consider any AMT liability. He or she can help yougift tax consequences. (See page 14.) Beyond gains and losses plan accordingly. w With some types of investments, you’llLoss carryovers have more tax consequences to considerIf net losses exceed net gains, you can than just gains and losses:deduct only $3,000 ($1,500 for married Dividend-producing investments.taxpayers filing separately) of the net Currently, qualified dividends arelosses per year against ordinary income subject to the same 15% rate (or 0%(such as wages, self-employment and rate for taxpayers in the 10% or 15%business income, and interest). ordinary-income bracket) that applies toYou can carry forward excess losses long-term capital gains. Warning: Thisindefinitely. Loss carry vers can be a o tax treatment is scheduled to change inpowerful tax-saving tool in future years 2013. (See “What’s new!” at left.)if you have a large investment portfolio, Interest-producing investments.real estate holdings or a closely held Interest income generally is taxed at
BUSINESSBoost your bottom line by reducing taxes It’s not how much money your business makes that really matters, but how much money it keeps. And taxes can take a large bite out of your bottom line. To boost it, reduce your taxes by using all the breaks available to you. Unfortunately, many breaks have expired or become less powerful this year. Still, there are plenty of opportunities out there, and, with smart planning, you can make the most of them.Projecting income Taking the opposite approach. If it’s cost of purchasing such assets as equip-Projecting your business’s income for likely you’ll be in a higher tax bracket ment, furniture and off-the-shelf com-this year and next will allow you to next year, accelerating income and defer- puter software. For 2012, the expensingtime income and deductions to your ring deductible expenses may save you limit is $139,000. The break begins toadvantage. It’s generally — but not more tax. Warning: Individual income phase out dollar-for-dollar when totalalways — better to defer tax, so consider: tax rates are scheduled to go up in 2013. asset acquisitions for the tax year exceed (See Chart 1 on page 2.) So if your busi- $560,000. You can claim the electionDeferring income to next year. If ness structure is a flow-through entity, only to offset net income, not to reduceyour business uses the cash method of you may face higher rates even if your it below zero to create a net operatingaccounting, you can defer billing for your tax bracket remains the same. loss. (See “NOLs” on page 10.)products or services. Or, if you use theaccrual method, you can delay shipping If your asset purchases for the year will Depreciationproducts or delivering services. But don’t exceed the phaseout threshold or your For assets with a useful life of more thanlet tax considerations get in the way of net income, consider 50% bonus depre- one year, you generally must depreciatemaking sound business decisions. ciation. (See “What’s new!” at right.) It the cost over a period of years. In most may provide greater tax savings becauseAccelerating deductible expenses cases, the Modified Accelerated Cost it has no asset purchase limit or netinto the current year. This also Recovery System (MACRS) will be prefer- income requirement. But only Sec. 179will defer tax. If you’re a cash-basis able to the straight-line method because expensing can be applied to used assets.taxpayer, you may make a state esti- you’ll get larger deductions in the early Also consider state tax consequences.mated tax payment before Dec. 31, years of an asset’s life.so you can deduct it this year rather Warning: The expensing limit and phase- But if you make more than 40% of thethan next. But consider the alternative out threshold have dropped significantly year’s asset purchases in the last quarter,minimum tax (AMT) consequences from their 2011 levels of $500,000 you could be subject to the typicallyfirst. Both cash- and accrual-basis and $2 million, respectively. And for less favorable midquarter convention.taxpayers can charge expenses on a 2013, these amounts are scheduled to Careful planning can help you maximizecredit card and deduct them in the drop again, to $25,000 and $200,000. depreciation deductions in the year ofyear charged, regardless of when the Also, the break allowing up to $250,000 purchase.credit card bill is paid. of Sec. 179 expensing for qualified Other depreciation-related breaks and leasehold-improvement, restaurant andWarning: Think twice about these retail-improvement property has expired. strategies also are available:strategies if you’re experiencing a low- Congress may extend the enhancedincome year. Their negative impact on Section 179 expensing election. This Sec. 179 breaks, however, so check withyour cash flow may not be worth the election allows you to deduct (rather than your tax advisor for the latest information.potential tax benefit. depreciate over a number of years) the
BUSINESS 9Accelerated depreciation. The break rules for the first year is limited under is also limited to 50% of W-2 wagesallowing a shortened recovery period the luxury auto rules. paid by the taxpayer that are allocable toof 15 years — rather than 39 years — domestic production gross receipts. In addition, if a vehicle is used for busi-for qualified leasehold-improvement, ness and personal purposes, the associ- The deduction is available to traditionalrestaurant and retail-improvement ated expenses, including depreciation, manufacturers and to businesses engagedproperty has expired, though it may be must be allocated between deductible in activities such as construction, engi-extended. Check with your tax advisor business use and nondeductible personal neering, architecture, computer softwarefor the latest information. use. The depreciation limit is reduced if production and agricultural processing.Cost segregation study. If you’ve the business use is less than 100%. If It isn’t allowed in determining net self-recently purchased or built a building or business use is 50% or less, you can’t use employment earnings and generally can’tare remodeling existing space, consider Sec. 179 expensing, bonus depreciation reduce net income below zero. But it cana cost segregation study. It identifies or the accelerated regular MACRS; you be used against the AMT.property components and related costs must use the straight-line method.that can be depreciated much faster, Employee benefitsperhaps dramatically increasing your cur- Manufacturers’ deduction Offering a variety of benefits can helprent deductions. Typical assets that qualify The manufacturers’ deduction, also called you not only attract and retain the bestinclude decorative fixtures, security equip- the “Section 199” or “domestic produc- employees, but also save tax:ment, parking lots and landscaping. tion activities deduction,” is 9% of the Qualified deferred compensation lesser of qualified production activitiesThe benefit of a cost segregation study plans. These include pension, profit- income or taxable income. The deductionmay be limited in certain circumstances — sharing, SEP and 401(k) plans, as wellfor example, if the business is subjectto the AMT or is located in a state that Take advantage of bonusdoesn’t follow federal depreciation rules. WHAT’S NEW! depreciation while it’s still availableVehicle-related deductions Who’s affected: Businesses that have made or are considering asset purchases.Business-related vehicle expenses can Key changes: The additional first-year depreciation allowance is 50% for 2012,be deducted using the mileage-rate down significantly from the 2011 percentage. (See the chart below.) Qualified assetsmethod (55.5 cents per mile driven in include new tangible property with a recovery period of 20 years or less (such as2012) or the actual-cost method (total office furniture, equipment and company-owned vehicles), off-the-shelf computerout-of-pocket expenses for fuel, insur- software, water utility property and qualified leasehold-improvement property.ance and repairs, plus depreciation). Corporations can accelerate certain credits in lieu of claiming bonus depreciationPurchases of new or used vehicles may for qualified assets acquired and placed in service through Dec. 31, 2012. (Forbe eligible for Sec. 179 expensing, and certain long-lived and transportation property, the deadline is Dec. 31, 2013.)purchases of new vehicles may be eligiblefor bonus depreciation. (See “What’s Planning tips: If you’re eligible for full Section 179 expensing (see page 8), it maynew!” at right.) However, many rules provide a greater benefit this year because it can allow you to deduct 100% of anand limits apply. asset acquisition’s cost. Plus, only Sec. 179 expensing is available for used property. However, bonus depreciation may benefit more taxpayers than Sec. 179 expens-For example, the normal Sec. 179 ing, because it isn’t subject to any asset purchase limit or net income requirement.expensing limit generally applies to If you’re anticipating major purchases of assets in the next year or two that wouldvehicles weighing more than 14,000 qualify, you may want to time them so you can benefit from bonus depreciationpounds, but the limit is only $25,000 for while it’s available.SUVs weighing more than 6,000 poundsbut no more than 14,000 pounds. Qualified assets acquired and placed in service Bonus depreciationVehicles weighing 6,000 pounds or lessdon’t satisfy the SUV definition and thus Jan. 1, 2008, through Sept. 8, 2010 50%are subject to the passenger automobile Sept. 9, 2010, through Dec. 31, 2011 100%limits. For autos placed in service in2012, the depreciation limit is $3,160. Jan. 1, 2012, through Dec. 31, 2012 50%The limit is increased by $8,000 for vehi- After Dec. 31, 2012 nonecles eligible for bonus depreciation. Theamount that may be deducted under Note: Later deadlines apply to certain long-lived and transportation property. Also, an extension of 100% bonus depreciation has been proposed; check with your tax advisorthe combination of MACRS deprecia- for the latest information.tion, Sec. 179 and bonus depreciation
10 BUSINESS as SIMPLEs. You take a tax deduction Remember: A hike in individual income tax may be eligible for a $500 credit per for your contributions to employees’ rates is scheduled for 2013. (See Chart 1 year for three years. The credit is limited accounts, and the plans offer tax-deferred on page 2.) So if your business structure to 50% of qualified startup costs. savings benefits for employees. (For is a flow-through entity (see Chart 4), you Research credit. This credit (also more on the benefits to employees, see may face higher rates in future years. commonly referred to as the “research page 12.) Certain small employers may and development” or “research and also be eligible for a credit when setting Tax credits experimentation” credit) has expired, up a plan. (See “Tax credits” at right.) Tax credits reduce tax liability dollar-for- but there’s been much discussion about dollar, making them particularly valuable. HSAs and FSAs. If you provide employ- extending it and even making it perma- Numerous types of credits are available ees with qualified high-deductible health nent. The credit generally is equal to a to businesses, but many expired after insurance, you can also offer them Health portion of qualified research expenses. 2011 and, as of this writing, haven’t yet Savings Accounts. Regardless of the type been extended. (Check with your tax Energy-related credits. Because of of health insurance you provide, you advisor for the latest information.) Here either 2011 expiration dates or restric- can offer Flexible Spending Accounts for are a few credits to consider: tions based on units sold, these credits health care. (See “Saving for health care” generally won’t be available for 2012 on page 3.) If you have employees who Health care coverage credit for small unless extended again. incur day care expenses, consider offering businesses. For tax years 2010 to 2013, FSAs for child and dependent care. (See the maximum credit is 35% of group Other credits. Examples of other “Child care expenses” on page 4.) health coverage premiums paid by the credits that have expired but that may employer, provided it contributes at be extended are the empowerment Fringe benefits. Some fringe benefits — least 50% of the total premium or of a zone tax credit and certain disaster relief such as employee discounts, group term- benchmark premium. The full credit is credits for the Gulf Opportunity Zone. life insurance (up to $50,000 annually per available for employers with 10 or fewer person), health insurance, parking (up to full-time equivalent employees (FTEs) Business structure $240 per month) and mass transit / van and average annual wages of less than Income taxation and owner liability are the pooling (up to $125 per month) — aren’t $25,000 per employee. Partial credits are main factors that differentiate one busi- included in employee income. Yet the available on a sliding scale to businesses ness structure from another. (See Chart 4 employer can still receive a deduction and with fewer than 25 FTEs and average to compare the tax treatments.) Many typically avoids payroll tax as well. Certain annual wages of less than $50,000. businesses choose entities that combine small businesses providing health care flow-through taxation with limited liability, coverage may be eligible for a tax credit. Retirement plan credit. Small employ- namely limited liability companies (LLCs) (See “Tax credits” at right.) ers (generally those with 100 or fewer and S corporations. Sometimes it makes employees) that create a retirement plan NQDC. Nonqualified deferred compen- sation plans generally aren’t subject to nondiscrimination rules, so they can be Work Opportunity credit extended WHAT’S NEW! and expanded for veterans used to provide substantial benefits to key employees. But the employer gener- Who’s affected: Businesses hiring veterans. ally doesn’t get a deduction for NQDC plan contributions until the employee Key changes: The Work Opportunity credit generally benefits businesses hiring recognizes the income. employees from certain disadvantaged groups, such as ex-felons, food stamp recipients and disabled veterans. As of this writing, the credit has expired for most NOLs groups. However, the VOW to Hire Heroes Act of 2011 extended the credit through 2012 for employers that hire qualified veterans. It also expanded the credit by: A net operating loss occurs when operat- ing expenses and other deductions for the n Doubling the maximum credit — to $9,600 — for disabled veterans who’ve year exceed revenues. Generally, an NOL been unemployed for six months or more in the preceding year, may be carried back two years to generate n Adding a credit of up to $5,600 for hiring nondisabled veterans who’ve a refund. Any loss not absorbed is carried been unemployed for six months or more in the preceding year, and forward up to 20 years to offset income. n Adding a credit of up to $2,400 for hiring nondisabled veterans who’ve Carrying back an NOL may provide a been unemployed for four weeks or more, but less than six months, in the needed influx of cash. But you can elect preceding year. to forgo the carryback if carrying the Planning tips: If you need to add to your staff, consider hiring veterans. To be entire loss forward may be more benefi- eligible for the credit, you must take certain actions before and shortly after you hire cial, such as if you expect your income to a qualified veteran. Your tax advisor can help you determine what you need to do. increase substantially or tax rates to go up.
BUSINESS 11 Installment sale. A taxable sale may CHART 4 Tax differences based on business structure be structured as an installment sale, due to the buyer’s lack of sufficient Flow-through entity cash or the seller’s desire to spread the or sole proprietorship C corporation gain over a number of years — or when One level of taxation: The business’s Two levels of taxation: The business is the buyer pays a contingent amount income flows through to the owner(s). taxed on income, and then shareholders based on the business’s performance. are taxed on any dividends they receive. But an installment sale can backfire on the seller. For example: Losses flow through to the owner(s). Losses remain at the corporate level. n Depreciation recapture must be For 2012, the top individual tax For 2012, the top corporate tax rate reported as gain in the year of rate is 35%. is generally 35%1, and dividends are sale, no matter how much cash generally taxed at 15%. the seller receives. 1 See Chart 8 on page 16 for exceptions. n If tax rates increase, the overall tax could wind up being more.sense to change business structures, but Sale or acquisition (Remember, the favorable 15%there may be unwelcome tax conse- Whether you’re selling your business rate on long-term capital gains isquences. Your tax advisor can help you as part of an exit strategy or acquiring scheduled to end after Dec. 31,determine whether a change would another company to help grow your 2012. See Chart 3 on page 7.)make sense for your company. business, the tax consequences can Of course, tax consequences are onlySome tax differences between structures have a major impact on the transaction’s one of many important considerationsmay provide tax planning opportunities, success or failure. Here are a few key tax when planning a sale or acquisition.such as differences related to salary vs. considerations:distributions/dividends: Asset vs. stock sale. With a corpora- The self-employed tion, sellers typically prefer a stock sale If you’re self-employed, you can deductS corporations. To reduce their employ- for the capital gains treatment and to 100% of health insurance costs forment taxes, shareholder-employees may avoid double taxation. (For more on yourself, your spouse and your depen-want to keep their salaries relatively capital gains tax, see page 6.) Buyers dents. This above-the-line deductionlow and increase their distributions generally want an asset sale to maximize is limited to your net self-employmentof company income (which generally future depreciation write-offs. income. You also can take an above-the-isn’t taxed at the corporate level). But line deduction for contributions made toto avoid potential back taxes and penal- Tax-deferred transfer vs. taxable a retirement plan and, if you’re eligible,ties, shareholder-employees must take sale. A transfer of corporation owner- an HSA for yourself.a “reasonable” salary. What’s consid- ship can be tax-deferred if made solelyered “reasonable” is determined by the in exchange for stock or securities of You pay both the employee and employerspecific facts and circumstances, but it’s the recipient corporation in a qualifying portions of employment taxes on yourgenerally what the company would pay reorganization. But the transaction must self-employment income. Generally, half ofan outsider to perform the same services. comply with strict rules. the tax paid is deductible above the line.C corporations. Shareholder-employees Although it’s generally better to post- However, the 2011 reduction of themay prefer to take more income as pone tax, there are some advantages to employee portion of the Social Security taxsalary (which is deductible at the a taxable sale: from 6.2% to 4.2% has been extendedcorporate level though it will be subject to 2012, and thus the Social Security tax n The parties don’t have to meetto employment taxes) as opposed to on self-employment income is reduceddividends (which aren’t deductible at the technical requirements of a from 12.4% to 10.4%. This doesn’tthe corporate level and are taxed at tax-deferred transfer. reduce your deduction for the employer’sthe shareholder level but not subject to n The seller doesn’t have to worry share of these taxes — you can still deductemployment taxes) because the overall about the quality of buyer stock the full 6.2% employer portion of Socialtax paid by both the corporation and or other business risks of a tax- Security tax, along with one-half of thethe shareholder-employee may be less. deferred transfer. Medicare tax, for a full 7.65% deduction. n The buyer enjoys a stepped-upWarning: The IRS is cracking down And you may be able to deduct homeon misclassification of corporate pay- basis in its acquisition’s assets and office expenses against your self-ments to shareholder-employees, so doesn’t have to deal with the seller employment income. (See “Hometread carefully. as a continuing equity owner. office deduction” on page 3.) w
RETIREMENTThe ins and outs of tax-advantaged retirement plans For many, building and preserving a substantial nest egg for retirement is among their most important financial goals. Fortunately, there are many tax-advantaged retirement plans available that can help you do just that. By contributing as much as possible, you can help ensure a financially secure retirement. But these plans also come with some potential pitfalls that you can fall into if you’re not careful. So it’s important to understand the ins and outs of the plans you use.401(k)s and other If your employer offers a match, at mini- though your deduction may be limited ifemployer plans mum contribute the amount necessary your spouse participates in an employer-Contributing to a traditional employer- to get the maximum match so you don’t sponsored plan. You can make 2012sponsored defined contribution plan miss out on that “free” money. (If your contributions as late as April 15, 2013.is usually the first step in retirement employer provides a SIMPLE, it’s required (See Chart 5 for contribution limits.)planning: to make contributions — though not necessarily annually.) Roth options n Contributions are typically pretax, A potential downside of tax-deferred reducing your taxable income. More tax-deferred options saving is that you’ll have to pay taxes n Plan assets can grow tax-deferred — In certain situations, other tax-deferred when you make withdrawals at retire- meaning you pay no income tax until savings options may be available: ment. Roth plans, however, allow you take distributions. tax-free distributions; the tradeoff is You’re a business owner or self- n Your employer may match some or that contributions to these plans don’t employed. You may be able to set up all of your contributions pretax. reduce your current-year taxable income: a plan that allows you to make muchChart 5 shows the 2012 employee con- larger contributions. You might not have 1. Roth IRAs. An added benefit is thattribution limits. Because of tax-deferred to make 2012 contributions, or even set Roth IRAs can provide estate planningcompounding, increasing your contribu- up the plan, before year end. advantages: Unlike other retirement plans,tions sooner rather than later can have a Roth IRAs don’t require you to take distri- Your employer doesn’t offer a retire-significant impact on the size of your nest butions during your lifetime. So you can ment plan. Consider a traditional IRA.egg at retirement. (See Case Study I.) let the entire balance grow tax-free over You can likely deduct your contributions, your lifetime for the benefit of your heirs. But Roth IRAs are subject to the same low CHART 5 Retirement plan contribution limits for 2012 annual contribution limit as traditional IRAs (see Chart 5), and your Roth IRA Limit for taxpayers Limit for taxpayers under age 50 age 50 and older limit is reduced by any traditional IRA contributions you make for the year. An Traditional and Roth IRAs $ 5,000 $ 6,000 income-based phaseout may also reduce 401(k)s, 403(b)s, or eliminate your ability to contribute. $ 17,000 $ 22,500 457s and SARSEPs1 2. Roth conversions. If you have a tra- SIMPLEs $ 11,500 $ 14,000 ditional IRA, consider whether you might benefit from converting all or a portion of 1 Includes Roth versions where applicable. it to a Roth IRA. A conversion can allow Note: Other factors may further limit your maximum contribution. you to turn tax-deferred future growth
RETIREMENT 13into tax-free growth and take advantage 4. Roth 401(k), Roth 403(b), and be better off withdrawing from that.of a Roth IRA’s estate planning benefits. Roth 457 plans. If the plan allows it, You can withdraw up to your contribu- you may designate some or all of your tion amount free of tax and penalty.There’s no longer an income-based limit contributions as Roth contributions. Another option, if your employer-on who can convert to a Roth IRA. But the (Any employer match will be made to sponsored plan allows it, is to take aconverted amount is taxable in the year a traditional plan.) No income-based plan loan. You’ll have to pay it backof the conversion. Whether a conversion phaseout applies, so even high-income with interest and make regular principalmakes sense for you depends on factors taxpayers can contribute. payments, but you won’t be subject tosuch as your age, whether you can afford current taxes or penalties.to pay the tax on the conversion, your tax Early withdrawalsbracket now and expected tax bracket in Early distribution rules are also important If you’re facing financial challenges, it mayretirement, and whether you’ll need the to be aware of if you change jobs or be tempting to make withdrawals fromIRA funds in retirement. retire and receive a lump-sum distribution your retirement plans. But generally this from your employer’s retirement plan. To3. “Back door” Roth IRAs. If the should be a last resort. With a few excep- avoid the early-withdrawal penalty andincome-based phaseout prevents you tions, distributions made before age 59½ other negative income tax consequences,from making Roth IRA contributions and are subject to a 10% penalty on top of request a direct rollover from your oldyou don’t have a traditional IRA, con- any income tax that ordinarily would be plan to your new plan or IRA.sider setting up a traditional account and due on a withdrawal. This means that youmaking a nondeductible contribution to can lose a substantial amount to taxes Otherwise, you’ll need to make an indirectit. You can then wait until the transac- and penalties. Additionally, you’ll lose the rollover within 60 days to avoid tax andtion clears and convert the traditional potential tax-deferred future growth on potential penalties. Warning: The checkaccount to a Roth account. The only the amount you’ve withdrawn. you receive from your old plan may be nettax due will be on any growth in the of 20% federal income tax withholding. If you must make an early withdrawalaccount between the time you made the If you don’t roll over the gross amount and you have a Roth account, you maycontribution and the date of conversion. (making up for the withheld amount with other funds), you’ll be subject to income tax — and potentially the 10% penalty — CASE STUDY I on the difference. Contributing a little more now can result in a substantially larger nest egg Required minimum distributions After you reach age 70½, you must take When Elizabeth is age 42, she starts a new job and decides to contribute $10,000 annual required minimum distributions of her salary annually to her employer’s traditional 401(k) plan. After 10 years, (RMDs) from your IRAs (except Roth IRAs) she increases her contributions to $15,000 per year. and, generally, from your defined con- Victoria is also 42, and she starts contributing to her employer’s traditional 401(k) tribution plans. If you don’t comply, you plan on the same day. But she decides to immediately defer $15,000 of her salary can owe a penalty equal to 50% of the annually. Remember, the contributions are before tax. So if Victoria is in the 28% amount you should have withdrawn but tax bracket, her extra $5,000 per year contribution is costing her only $3,600 — or didn’t. You can avoid the RMD rule for $300 per month. (And that doesn’t even take into account any state tax savings.) a Roth 401(k), Roth 403(b) or Roth 457 plan by rolling the funds into a Roth IRA. Elizabeth and Victoria both enjoy a 6% rate of return and maintain their annual con- tributions for 25 years, until they retire at age 67. At retirement, Victoria’s plan has So, should you take distributions between $157,942 more than Elizabeth’s, even though she contributed only $50,000 more. ages 59½ and 70½, or take more than the RMD after age 70½? Distributions As you can see, making additional contributions now that cost you only a few in any year your tax bracket is low may hundred dollars more per month can result in a substantially larger nest egg at be beneficial. But also consider the lost retirement than if you wait to increase your contributions. future tax-deferred growth and, if appli- Total contributions made cable, whether the distribution could: 1) cause your Social Security payments to Elizabeth: $325,000 become taxable, 2) increase income-based Victoria: $375,000 Medicare premiums and prescription drug Balance at age 67 charges, or 3) affect other deductions or Elizabeth: $665,026 credits with income-based limits. Victoria: $822,968 If you’ve inherited a retirement plan, Note: This example doesn’t consider employer matching. It’s for illustrative purposes only consult your tax advisor regarding the and isn’t a guarantee of future results. applicable distribution rules. w
ESTATE PLANNINGWhy estate planning continues to be a challenge Estate planning is never easy. You must address your own mortality while determining the best strategies to ensure that your assets will be distributed according to your wishes and that your loved ones will be provided for after you’re gone. You also must consider how loved ones will react to your estate planning decisions, which may be difficult if, for example, a family business is involved or you wish to provide more to certain family members. But estate planning may be especially challenging this year because of uncertainty about whether favorable exemptions and rates will be allowed to expire in 2013 as scheduled.Estate tax or 2012, unless Congress extends it. You can exclude certain gifts of upThe current estate tax exemption is at Also, exemption portability doesn’t pro- to $13,000 per recipient each yearan all-time high, and the top estate tect future growth on assets from estate ($26,000 per recipient if your spousetax rate remains low. But the favorable tax as effectively as applying the exemp- elects to split the gift with you or you’reexemption and rate will be in effect only tion to a credit shelter trust does. giving community property) withoutthrough 2012 unless Congress extends using up any of your gift tax exemption. So married couples should still considerthem. (See Chart 6.) making asset transfers and setting up GST taxAlso set to expire is exemption “portabil- trusts to ensure they take full advantage The generation-skipping transfer tax gen-ity” between spouses: If part (or all) of one of both spouses’ exemptions. Transfers to erally applies to transfers (both during lifespouse’s estate tax exemption is unused your spouse — during life or at death — and at death) made to people more thanat death, the estate can elect to permit are tax-free under the marital deduction one generation below you, such as yourthe surviving spouse to use the deceased (assuming he or she is a U.S. citizen). grandchildren. This is in addition to anyspouse’s remaining estate tax exemption. Gift tax gift or estate tax due. The GST tax alsoMaking this election is simple and provides follows the estate tax exemption and topflexibility if proper planning hasn’t been The gift tax follows the estate tax exemp- rate for 2012. (See Chart 6.)done before the first spouse’s death. tion and top rate for 2012. (See Chart 6.) Any gift tax exemption used during life Warning: Exemption portabilityBut the election is available only to the reduces the estate tax exemption available between spouses doesn’t apply to theestates of spouses who’ve died in 2011 at death. GST tax exemption. CHART 6 Transfer tax exemptions and highest rates Highest estate and gift Year Estate tax exemption1 Gift tax exemption GST tax exemption tax rates and GST tax rate 2011 $ 5 million $ 5 million $ 5 million 35% 2012 $ 5.12 million $ 5.12 million $ 5.12 million 35% 20132 $ 1 million $ 1 million $ 1 million 3 55% 4 1 Less any gift tax exemption already used during life. 2 Assuming legislation isn’t signed into law extending current levels or making other changes. Contact your tax advisor for the latest information. 3 Indexed for inflation. 4 The benefits of the graduated gift and estate tax rates and exemptions are phased out for gifts and estates over $10 million.